The real victims of China’s yuan policy

Frustration in Washington is growing over China’s contorted policy on its currency, the yuan. And for good reason. A so-called “reform” of the regime introduced in June, in which Beijing finally ended a de facto two-year yuan-dollar peg and permitted its currency to “float” in a narrow band, has proven to be a big yawn. The yuan has barely budged against the dollar since then. That has only fueled criticism in Washington that China keeps the yuan artificially cheap to give Chinese exports an unfair price advantage in global markets. A bill is gaining momentum in the House of Representatives that would instruct the Commerce Department to slap duties on imports from countries that undervalue their currencies – in other words, China. Treasury Secretary Timothy Geithner will testify in Congress on the yuan issue today, and he looks set to take his toughest position yet. In his testimony, released in advance on Wednesday, Geithner made clear that the U.S. is considering new steps to pressure China to allow the yuan to strengthen. Here’s a sample of his comments, courtesy of Reuters:

We are concerned, as are many of China’s trading partners, that the pace of appreciation has been too slow and the extent of appreciation too limited…We are examining the important question of what mix of tools, those available to the United States and multilateral approaches, might help encourage the Chinese authorities to move more quickly.

What Washington eventually decides to do on the currency issue will set the tone for China-U.S. relations for some time. My own opinion is that the U.S. fixation on the yuan is overcooked. But that doesn’t mean China’s currency regime is benign. Far from it. The real victims of China’s stubborn insistence on controlling its currency can be found throughout the developing world – the hundreds of millions of people still trapped in poverty who desperately need the job opportunities China is hoarding for itself.

Though there is no clear consensus on how undervalued the yuan might be, it is clearly undervalued. We know that because on the rare occasions when Beijing lets the currency actually move it tends to strengthen, as it has over the past week. A stronger yuan would be good for everyone. For China, it would help with the crucial transition the country needs to make to “rebalance” its economy, away from its unstable invest-and-export growth model towards one more reliant on domestic consumption. A more expensive yuan would make imports into China cheaper for Chinese companies and consumers, possibly stimulating American exports to China and creating much-needed jobs in the U.S. That, in turn, would help reduce China’s giant current account surplus, which is the target of American ire.

However, in my opinion, the overall impact of a stronger yuan on the U.S. economy won’t be as dramatic as many Americans seem to believe. A stronger yuan would raise the prices of Chinese-made goods in U.S. stores, which would further tax the already stretched American consumer. Nor will it result in a flood of factories and jobs retracing their steps across the Pacific as many seem to hope. Perhaps a stronger yuan would encourage a few American companies to move or maintain production facilities back home, but probably not enough to make that much of a difference. A stronger yuan might thus change the American trade relationship with China, but not necessarily change the face of American manufacturing. That’s because there are too many cheaper places than the U.S. where multinational companies can open factories. Rather than setting up shop in Ohio or South Carolina, a manufacturer can tap into the low wages of India, Indonesia, Bangladesh, and a host of others.

But it is here where we can truly find the damage done by China’s currency policy. By controlling the value of the yuan, Beijing is likely depriving the poorest nations of the world of their chance at a China-style economic miracle. That’s because the cheap yuan is stunting the progress of export sectors in other developing economies, in two key ways. First, it keeps Chinese manufactured exports relatively more competitive versus rival products from other emerging economies. That blunts export growth from those poor nations. Secondly, it makes other developing economies relatively less attractive as investment destinations for exporters. In both cases, China’s policy is curtailing job creation in poor countries.

China jumpstarted its growth story by wooing labor-intensive production from higher-cost countries, thus creating jobs in new export industries and alleviating poverty. In theory, as China developed and costs rose, the economy would no longer remain a competitive locale for some of that production, especially of low-end goods like apparel and electronics. By keeping the yuan extra-cheap, however, China is likely holding onto at least some of that production longer than it otherwise would. That’s because if the yuan appreciated, products made in Chinese factories would become more expensive in world markets, causing buyers from the U.S. and Europe to look to manufacturers from other developing nations for a better buy. Factories would likely close up shop in China and reopen in cheaper places, or new factories that might have come to China would get diverted to competitors. The effect of an appreciating yuan would combine with rising wages and other costs within China – which are already straining the profit margins of many of China’s exporters — and act as further encouragement for manufacturers to look for less costly places to base their factories.

As a result, we’d see a shift of export production, and therefore employment, from China to other emerging markets. The Cambodias and Bangladeshes of the world could get their hands on more of those low-end factory jobs that proved so crucial to obliterating poverty in China and Asia’s other rapidly developing economies. By not allowing this natural shift of work to take place as quickly as it should, China is contributing to the persistence of global poverty.

Of course, a strengthening currency wouldn’t deprive China of its export machine. China has competitive advantages that go beyond cost, like solid infrastructure. But it is undeniable that labor-intensive production of low-end goods is already shifting out of China due to its more expensive business environment, even with a depressed yuan. Vietnam in recent years has been a big beneficiary of this trend, as manufacturers have flocked to China’s Communist neighbor as a new, lower-cost alternative.

The possibility that Vietnam and other poor countries could steal away China’s exports and jobs is exactly why Beijing won’t let its currency loose. The people who should really be furious at Beijing are Mumbai slum dwellers and destitute African villagers, not the U.S. Congress.